How forensic accounting can snuff out fraud and mismanagement

By: | 2:28pm EST September 2, 2013

With increased regulatory demands and constant threats of fraud and misconduct, businesses have to watch their backs, especially when it comes to finances. In many cases, having a traditional accountant is not enough. Instead, you may need someone who has not only accounting skills, but investigative and analytical skills as well. In other words, you need a forensic accountant.

“Forensic accounting enables business owners to get control over possible financial fraud and mismanagement and, more importantly, to deter it before it occurs,” says James P. Martin, CMA, CIA, CFE, managing director at Cendrowski Corporate Advisors LLC.

He says forensic accountants can help companies design effective antifraud controls and mitigate the risks of future lawsuits. They also might be used to quantify economic damages in instances where value and/or profits might be lost, or in cases of business valuations to uncover reported income or expenses.

Smart Business spoke with Martin to learn more about forensic accounting.

How does a forensic accounting engagement differ from an audit?

First and foremost, forensic accounting engagements are nonrecurring and are only conducted at the request of a firm’s management. Audits, conversely, are recurring activities. Forensic accounting engagements are targeted assessments of specific areas of a business; they are not general assessments of the business as a whole or its financial statements.

The methodology employed in an audit is also quite different from that used in forensic accounting engagements. Audits are conducted primarily by examining financial data, whereas forensic accounting analyses are conducted by examining a wide variety of documents and interviews.

Lastly, the goals of forensic accounting engagements are yet again very different from audits. The goal of the latter is to detect the presence of material misstatements, irrespective of their cause. Audit activities are in no way designed to help an organization deter fraud, though they may detect such activity.

Because many frauds begin on a small scale, they may go undetected by auditors if the size of the fraud is below the auditor’s threshold for materiality. Moreover, even if the magnitude of a fraud is greater than the auditor’s threshold for materiality, a fraud may remain undetected by the auditor if it is well concealed. Forensic accounting engagements can be specifically tailored to deter fraud and potentially prevent it.

Can forensic accounting techniques be applied proactively?

Forensic accounting techniques can be used on a proactive basis in many instances, including the deterrence of fraud. More specifically, forensic accountants can proactively analyze an organization’s internal control process to determine areas of weakness and help the organization swiftly remediate these issues.

How can organizations use forensic accountants to help deter fraud?

Fraud deterrence focuses on removing one or more of the three causal factors of fraud: motive, opportunity and rationalization. Only when each of these factors is present can a fraud occur.

Motive and rationalization are generally dependent on personal situations over which the organization may have little control. This is why the opportunity for fraud is often the prime target of fraud deterrence engagements, as this factor can be controlled by an organization.

How can forensic accounting techniques be used in cases of business valuations?

Valuation professionals who are trained in forensic accounting may have significant experience in data mining and analysis, affording them the ability to supplement typical valuation techniques with information uncovered as a result of forensic accounting activities.

This additional information could result in a markedly different valuation from that which might have been calculated without the use of forensic accounting techniques, as valuations are extremely sensitive to underlying assumptions.

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